(PUB) Investing 2015

760 / 772

6 • Fund Family Shareholder Association
DISTRIBUTIONS
Gains Approaching
ONCE AGAIN, we’ve come to the end of the year—the time when we all
have to give at least a little thought to fund distributions. While some com-
panies do it in October, others wait until November. But Vanguard pays out
capital gains and quarterly distributions in December like clockwork.
Based on early estimates, shareholders in at least a few funds, includ-
ing Capital Value, Explorer, MidCap Growth, Morgan Growth,
Strategic Equity and U.S. Growth could see capital gains distributions
north of 7%. Those aren’t the double-digit gains seen in years past, but
they aren’t nothing. That’s why it pays to pay attention to the calendar.
One hazard of investing with successful stock pickers who have been
at it for a long time is that some distributions are unavoidable. The
PRIMECAP Management team and Wellington health care team fit this
mold. Both teams are excellent at picking stocks and are very patient
(they hold stocks for years). In addition to racking up satisfying returns
for investors, this means that over time, unrealized gains have built up in
their portfolios, and as the managers continue to position their funds for
the best gains moving forward, they are forced to pay out some of those
profits. (This is one reason I was quick to suggest that investors look to
the PRIMECAP Odyssey funds when they launched a little over a decade
ago.) We all prefer smaller tax bills, but don’t let the tax tail wag your
portfolio dog—the PRIMECAP team and Jean Hynes of the Wellington
health care team are among the best in the business and should continue
to make up for a bigger tax bill with even bigger returns. This year the
expected distributions for Health Care and all of the PRIMECAP-run
Vanguard funds are modest—between 3.5% and 4.5%.
You’ll notice I haven’t mentioned any foreign stock funds yet. Well,
the list of Vanguard funds distributing gains this year is dominated
by U.S. funds. Strong gains over the past nearly seven years means
that the losses booked during the credit crisis have been exhausted.
But gains have not been as strong in overseas markets—Total
International Stock is “only” up 123.3% since the market bottomed
in March 2009, while Total Stock Market has gained 260.2%—so
most of Vanguard’s foreign stock funds still have losses on the books.
The two exceptions are International Explorer, which has outpaced
its foreign stock siblings at Vanguard since the market’s nadir, and
Global Minimum Volatility, which wasn’t around to book losses
during the credit crisis. The realized losses on the other foreign stock
funds are quickly evaporating, though, so enjoy the lack of distribu-
tions this time around. If foreign markets rally next year, I’d expect
to see more of the overseas funds distributing gains alongside their
domestic counterparts.
One fund that should not be distributing gains for years to come is
Precious Metals & Mining—and that’s about all investors have to be
thankful for at this time of the year. The fund has lost 20.6% a year over
the last five years, while Total Stock Market was growing at a 14.0%
rate. Ouch. The small silver lining for investors in Precious Metals &
Mining is that the managers have realized losses of 93% of NAV, and on
top of that, the fund is sitting on unrealized losses of 60% or so of NAV.
WhenYou Shouldn’t Wash
If you’re making some trades to avoid distributions and/or to realize
losses in your taxable accounts, you need to know your distribution and
record dates so that you don’t run afoul of the wash-sale rule. In short,
if you sell a fund for a loss within 30 days of receiving more shares in a
reinvested distribution, you won’t be able to recognize the full loss since
the number of shares received in the reinvestment will count as shares
purchased within the 30-day window. Nor can you buy shares within 30
days of taking a loss without also running afoul of the wash-sale rule.
A couple of things to remember about distribution season: First, the
record date. If you own shares in a fund after the close of trading on
the record date, you will receive the distribution. You are, by definition, a
shareholder of record. You must sell a fund before or on the record date
to avoid the distribution.
The reinvestment or ex-dividend date is the day the fund’s price
drops by the amount of the distribution, though market action can cause
the fund’s price to move up or down independent of the actual size of
the distribution. The record date is the day before the distribution, or
ex-date, for open-end funds. But be forewarned that this is not the case
for ETFs. ETFs have a wacky distribution process due in part to the gap
between when you buy a stock (or ETF) and when your trade settles.
That’s the selling side. But there’s also the buying side. The general
rule of thumb is that investors in taxable accounts don’t want to “buy a
distribution.” (Those with IRAs or other tax-deferred accounts don’t have
to worry about this one.) Taxable investors don’t want to be investing in
a fund, or adding to it, right before it makes a distribution, since you are
immediately receiving some of your capital back in a form that is tax-
able. This is poor tax planning. It’s always tough to figure out how far
in advance of a distribution you should avoid buying shares in a fund.
Jeff uses a handy little metric he devised that says you stop buying one
week ahead of a distribution for every 1% of estimated NAV the fund is
for Long-Term Investment-Grade.
Second, keep in mind that Long-Term
Investment-Grade is still 90% man-
aged by Wellington, whereas the other
actively managed investment-grade
funds are run in-house by Vanguard, so
it’s possible that Wellington just did a
better job picking bonds and position-
ing the portfolio.
Still, the biggest difference in per-
formance is in the mortgage-backed
space. As the chart on page 5 shows,
manager Michael Garrett of Wellington
Management has led GNMA ahead
of Mortgage-Backed Securities ETF
despite fishing in a smaller pond.
Remember, the index holds Fannie Mae
(FNMA) and Freddie Mac (FHLMC)
issued mortgage-backed bonds in
addition to those issued by Ginnie
Mae (GNMA). The ETF has matched
GNMA over the past several years,
but I’d still favor the actively managed
fund and its current yield advantage of
2.43% to 1.60%.
Over the past three years or so,
Vanguard has further complicated mat-
ters for bond investors, launching a
handful of other bond index funds
and ETFs: Short-Term Inflation-
Protected Securities Index (which we
covered in-depth last month), Total
International Bond Index , Emerging
>